In the end, there’s a limit to the wall of worry that even the Indian equity market can climb. For too long, the country’s share markets marched on, seemingly oblivious of a growing list of negatives, ranging from flagging reform momentum and high valuations to a deteriorating political backdrop. But the events of the past few weeks, culminating in the presentation of a rather insipid Budget by India’s finance minister, seems to have finally broken the market’s momentum. This may take some gloss off the “India Rising” story.
In the fourth year of the strongest economic boom in its history, India has had to grapple with the problems of increasing inflation and, more worryingly, a political class that doesn’t believe good economics makes for good politics. That’s ironic, given that Finance Minister P. Chidambaram has been at the wheel. He’s counted as one of the few Indian politicians with a vision for economic development and has, over the years, been instrumental in implementing several path-breaking reforms, such as slashing corporate and personal taxes. But in a sign of changing times, he presented a budget that was long on socialistic rhetoric and short on any new reform initiatives.
It is fortunate that Mr. Chidambaram delivered his speech only a day after a clutch of state elections results were announced, in which his Congress party suffered major reversals. Had there been time, odds are that the finance minister would have crafted a more anti-market policy statement, taking into account the rapidly rising political perception that high economic growth doesn’t lead to electorate success.
The job of the erstwhile reformers, including that of the finance minister, was thus redefined to keeping bad ideas out and allowing the economy to benefit from globalization. In his previous budget speeches, Mr. Chidambaram performed that task adeptly. He often repackaged old spending plans, giving the impression to his political masters that the government was indulging in a more “inclusive” growth model, but in effect holding the increase in government spending well in check, as the nearby chart shows.
It is indeed remarkable that despite heavy political pressures, India’s government spending as a share of the gross domestic product has fallen to 14% from 16% under the current government. This has allowed the country’s fiscal deficit to fall to 3.7% of GDP.
Given the outcome of Monday’s state elections in Punjab, Uttarakhand and Manipur, it now increasingly seems that the appeal of populist policies may be too hard to counter. At nearly 7%, it’s true that India’s inflation rate is on the higher side of an average 5.5% for developing economies. Rising food prices, which form a large part of the average Indian’s consumption basket, constitute a major portion of India’s inflationary pressures. But the solution to inflation doesn’t lie in what seems to be the government’s knee-jerk reaction to the problem—increasing government spending and banning forward trading in key commodities. The answer, instead, is to reduce import duties further and let the Reserve Bank of India carry on freely with its job of normalizing interest rates. There needn’t be any trade off between growth and inflation if steps to enhance productivity are taken by making the economy more open and competitive.
The budget wasn’t all bad news. In an effort to address supply-side shortages, Mr. Chidambaram did announce a cut in the peak import tariff to 10% from 12.5%. However, given the revenue windfall from a fast expanding economy, there was scope for further cuts, especially in excise duties. For a finance minister who is most widely remembered for dramatic tax cuts in his 1997 budget, it’s disappointing to see that he hasn’t taken advantage of the buoyancy in tax revenues during these boom years to lighten the overall tax burden. The list of what the finance minister could have done in the budget runs long, but to be fair to Mr. Chidambaram there’s only so much he can do if the governing coalition lacks the political will to reform. The important questions now are what’s on the agenda for this government in the coming months and how much their actions will that affect India’s otherwise solid story.
To keep the growth momentum going, India will need a new set of economic reforms, ranging from greater privatization to further liberalization of foreign direct investment caps in important sectors such as insurance and retail. The current political context doesn’t make such moves likely to happen anytime soon.
Realistically, the best one can hope for is that the economy continues to profit from global trends—and the damage from India’s restless political quarters is kept to a minimum.
But the India story then becomes a tad less exciting than it was even a few weeks ago.
The Wall Street Journal
—Ruchir Sharma is the head of emerging markets at Morgan Stanley Investment Management